Ex-Treasury Secretary Summers warns of risks 'greater than any since aftermath of 9/11', reports Ambrose Evans-Pritchard
Subprime crisis in full
Ambrose Evans-Pritchard: Prepare for the crunch   
Larry Summers: 'It would be far too premature to judge this crisis over' 
Former US Treasury Secretary Larry Summers warned that the United States may be heading into recession as the biggest victim to date of the sub-prime mortgage debacle was humiliatingly sold for a token sum in Germany.
Traders are braced for another week of turmoil after the near breakdown of America's $2,200bn (£1,100bn) market for commercial paper.
"It would be far too premature to judge this crisis over," Mr Summers said. "I would say the risks of recession are now greater than they've been any time since the period in the aftermath of 9/11."
In Germany, it emerged that the state-bank SachsenLB may have accumulated $80bn of exposure to risky assets through a set of Irish funds kept off balance sheet.
advertisementThe regional government of Saxony agreed yesterday to sell the East German bank - the biggest victim so far of the worldwide credit rout - for a token €300m (£204m) to the Landesbank Baden-Württemberg in Stuttgart (LBBW), ending a three-week saga that has revealed the extent of German involvement in the some of the most treacherous areas of US sub-prime debt.
Georg Milbrandt, prime minister of Saxony, said the sale of state-owned lender was the only viable option.
"Given the market turbulence and the pressures on the bank, it could not have gone on without a partner. We want to get our ship off the high waves and into a safe port," he said.
Sachsen LB, founded in 1992 after the fall of the Berlin Wall, was rescued two weeks ago in a state orchestrated bail-out. A consortium of banks agreed to provide a €17.3bn credit lifeline, but only on the understanding that it agreed to be sold to a stronger player.
It allegedly used no fewer than five Irish 'conduits' (off-balance sheet vehicles) to invest in collateralised debt obligations (CDOs) and other high-risk instruments, according to German newspaper Süddeutsche Zeitung.
The biggest losses stemmed from structured investment vehicles (SIVs) which involve using short-term credit to buy longer-term assets, creating a mismatch in maturities.
The rescue deal comes as investors waited to learn whether the US Federal Reserve would succeed in stabilising the US commercial paper market, the latest - and biggest -domino to fall in the spreading contagion from sub-prime debt. Investors have suddenly lost trust in this form of debt, fearing it may be tainted by exposure to CDOs.
Stock markets rallied strongly late last week on the belief that the Federal Reserve would start to cut its key lending rate in September, and that the European Central Bank would refrain from further tightening. Goldman Sachs said any hint the banks may prove more hawkish could quickly dampen investor spirits again, warning it was too early to give "all clear" on equities.
Federal Reserve data shows that the outstanding stock of US commercial paper has fallen by $255bn over the last three weeks, a sign that borrowers have been unable to roll over huge amounts of debt. The fall is comparable to the sudden shrinkage that occurred at the onset of the dotcom bust, and may have the effect of draining liquidity.
The New York Fed issued a statement on Friday stressing that asset-backed commercial paper (ABCP) would be accepted as collateral for loans to banks from the discount window. The move has helped trim the average yield slightly to 6.04pc, helping to calm a key part of the money market that lubricates the financial system.
Even so, the cost of this credit is still up roughly 80 basis points since late July - for those borrowers who can obtain it at all. Bill Gross, head of the US bond-giant PIMCO, said parts of the commercial paper industry were now so discredited that it may be impossible to revive them.
A string of Germany banks have run into trouble after taking leveraged bets on CDOs and the even more deadly 'synthetic' or derivative CDOs - bond-like securities that often contain slices of US mortgage debt.
The scale of carnage in Europe explains the series of emergency actions by ECB, which injected a further $85bn in liquidity through various mechanisms last week. IKB was the first German bank to crumble earlier this month, requiring an €8.1bn state-rescue just days after it denied any significant exposure to sub-prime debt.
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